Introduction to Entrepreneurial Finance

entrepreneurial pay Philippe Gregoire Louvain School of Management Universite catholique de Louvain Reference book entrepreneurial finance, a casebook. Paul A. Gompers and William A. Sahlman. John Wiley & Sons, Inc. 2002 1 Entrepreneurial finance Project assessment (POCD) Funding (amount, firms mensurate, best provide) chew (ownership / control / incentives) Exit (IPO) Project Assessment 4 critical success factors for entrepreneurial ventures ? ? ? ? People Opportunity Deal setting 3 People Id rather spine a A team with a B idea than a B team with an A idea Who are the recognise players What is their experience How does this experience prepare or not prepare them for the fortune that exists What are strengths and weakness of the people involved on all sides of the transaction Are there key individuals that the company should add or replace 4 Opportunity unseasoned product / service ? Smartphone, New method of delivery ? Amazon. com New production technique ? Ernes t Solvay patent (1861) to manufacture soda ash (enter in detergent, glass, ) Is there a sustainable competitive advantage Must the opportunity be exploited immediately Are there intermediate milestones 5Deal Spending money is not enough. Incentives and contingencies are authorised considerations. ? Key to all these structural features is the concept of the entrepreneur earning his/her equity through value creation. Moral hazard and adverse weft ? Entrepreneur bear the downside risk Choice of appropriate investors ? for whom you raise capital of the United States is often more important than the terms Selection of the proper financial instrument ? ? ? Debt Equities Convertibles / preferred convertibles 6 Securities held by Venture Capitalists (Source Kaplan-Stromberg, 2003) Context Competition Regulation International environment Economic conditions 8 Introduction to entrepreneurial finance Finance ? Study of value and resources allocation (capital bud beat backing) Value of specie stream = f(magnitude, timing, riskiness) Economic value = Expected furnish = PV ? ? T t ? 1 E? Rt ? ? rf ? Risk premium CFt ? 1 ? E ? Rt t ? Cost of capital Capital rationing Entrepreneurship ? Focus on opportunities rather than controlling existing resources Entrepreneurial finance ? ? Financial management within entrepreneurial firmsStudy on both sides of the balanced sheet 9 The Balance Sheet of a Corporation Assets = use of funds Current (Short-term) assets Cash Accounts receivable Inventories Others (various claims) located (long-term) assets Land Buildings Machineries & Equipment Liabilities = sources of funds (Capital structure) Current (Short-term) Liabilities Accounts payable Short-term debt Long-term Liabilities Equity Provided by shareholders (= owners of the company) Long-term Debt Provided by creditors such as banks 10 Others Accounting Income versus Cash Flow Cash income ? ccounting income Whereas accountants try to match revenues with expe nses, managers and investors boil down on the difference between cash inflow and cash kayoedflow. Cash flow = the amount of cash income (= inflow outflow of cash) that is generated in any period Formally, 11 The Cash Cycle of a unanimous Cash cycle average time between when a firm pays for its inventory and when it receives cash from the barter of its product 12 Sources of Entrepreneurial Finance Bootstrapping Stock merchandises (IPO) 3Fs Leasing Governmental organizations 13 Section 1. Investment outline mental faculty 1. A Source of value ? ? Introduction to entrepreneurial finance Case train Module 1. B Financial statements and pro forma models ? Case study Module 1. C Purchasing firms, buyouts, and valuation ? ? evaluation in entrepreneurial finance Case study Additional (Optional) Reading and References Smith/Smith Entrepreneurial Finance, Wiley Edition. Sahlman/Stevenson/Roberts/Bhide The Entrepreneurial Venture, HBS Press. 14 Section 2. Financing the entrep reneurial firm Module 2. A Venture capital ? ? Private equity Case study Module 2.B Angel financing ? Case study 15 Section 3. Harvesting Module 3. A sign Public Offerings ? ? IPO process Case study Module 3. B Acquisitions ? Case study 16 Module 1A. Sources of value 4 stages of entrepreneurship ? ? ? ? Identifying opportunities Acquiring the financial, professional, and oil-bearing resources Implementing a plan of actions Harvesting the rewards 4 critical success factors for entrepreneurial ventures ? ? ? ? People Opportunity Deal Context 17 The unravel People Opportunity Valuation Deal structuring Source of capital 18 Business Case Success as one of the early AOL Greenhouse companies 3-book plentitude with Bantam Doubleday untouchable interest from advertisers Significant traffic at its website 2 issues Out of cash within 3 months draw for scale economies on the internet To build the country s number-one wedding resource, Liu needs 10 millions 19 People ( Core founding team) All media people with experience in software, video, etc. Good understanding of invent and presentation Lack of operational expertise, retail experience, and marketing 20 Opportunity Stable number of weddingRecessions give up very little impact Event tied to significant expenditures ? ? Wedding party Guests Size of the market (35 billion) High advertising rate Stagnant competition, lethargic and not very innovative Couples planning to worry married ? ? ? have relatively high income Are fairly young plan major disembodied spirit purchases ? are not very equipment casualty sensitive 21 Opportunity ? Cash Flow alter the opportunity into cash flow = Business model = set of factors that together determine the cash flows a company can generate and create value The Knot registry / advertising / merchandise / publish and others 2 22 The Knot People Opportunity Valuation Deal structuring Source of capital 23 Valuation Cash flow is the source of val ue To date, the Knot has ordered losses and is evaluate to post losses for at least 2 more years It is difficult to use earnings to image the probability of generating future cash flows. Revenues and mix of revenues appear to be a better measure five-fold of revenues method. Compare to firms on the basis of ? ? ? ? Stage of development Business model Target market surface Size of the investment round 24 List of comparable transactions 25Discount cash flow outline Most forecasts are widely optimistic. Discounted cash flow valuations only work when one gets an estimate of the expected CF 26 Actual income statement 27 Split of Revenues 28 Forecasted statement of cash flows 29 Actual statement of cash flows In Millions of USD (except for per share items) Net Income/Starting Line Depreciation/Depletion amortisation Deferred Taxes Non-Cash Items Changes in Working Capital Cash from Operating Activities 2011 5. 99 3. 74 0. 96 2. 78 11. 89 -1. 31 24. 05 2010 3. 65 3. 43 1. 78 2. 3 8 -8. 11 11. 06 2009 -4. 87 4. 75 5. 09 -1. 6 13. 83 -4. 92 12. 33 2008 4. 13 4. 84 3. 98 0. 56 6. 16 0. 2 19. 87 30 The Knot People Opportunity Valuation Deal structuring Source of capital 31 Initial deal Initial investment strategic partner ? Expect from AOL money, exposure and distribution more than entirely dollars to the deal AOL invested 1. 85 million in return for 45%, for royalties amounting to 20% of ad revenues on The Knots AOL site and a lesser % of ad revenues on The Knots internet site. ? The deal with AOL provided instant reach and credibility to The Knot Is the deal expensive for The Knot? 32Ownership after AOL deal 33 Financing the Knot (new deal) 34 Convertible preferred Preferred has higher priority than common occupation ? In the event of a firms sale or liquidation, holders of preferred stock get paid before common stockholders do. Entrepreneurs have greater incentive because if things dont go well, the investor forget be paid first Downside risk is borne by the entrepreneur ? ? Tax considerations ? Entrepreneurs pay taxes on the value of common stock that they have received. ? Investing in preferred stock does not change the price of common stocks. 35 Financing the Knot Why should they invest? To develop The Knot brand, to build out the technological infrastructure, to develop the gift registry avocation ? Practically, The Knot needs capital to fund the payroll department and pay for day-to-day operating expenses How much money? Forecasted statement of cash flow Who should invest in The Knot? Business Angel, Venture Capitalist, Strategic Partner How should they value The Knot? Comparable deals on the market, quaternate of revenues 36 Investors profile Angels + Higher valuation + Someone with an experience in the registry business Limited capital ? ay not be able to provide capital in the future if demand Less helpful in recruiting others to the team Venture Capitalist + + Large pools of capital and make ten-fo ld rounds of investment Network of contacts in the management and financial community Lower valuation Strategic partner + + Experience in the business (retailer, wedding registries,) Provide distribution and name recognition Conflicts of interest 37 What happened? May 1998, Venture Capitalist invested $3m for 22% ? $10. 6m pre-money valuation (3/(10. 6+3)=22%) April 1999, Venture Capitalist invested $15m celestial latitude 1999, IPO 38